Annuities

12.1. Introduction
12.2. Meaning of Annuity
12.3. Types of Annuities: Present and Future Values
12.3.1. Ordinary Annuity
12.3.2. Annuity Due
12.3.3. Deferred Annuity
12.3.4. Continuous Compounded Annuity
12.3.5. Perpetual Annuity
12.4. Depreciation of Assets and Depreciation Rates
12.5. Amortization of Loans
.' 12.6. Valuation of Bonds and Debent~res
12.7. Sinking Funds
Exercises
Answers

12.1 INTRODUCTION
In the previous chapter, we have learnt about computation of interest, as compensation to the lender
for dispensing with the funds for a certain period of time, As a result, the concept of time value of
money emerged that culminated into the principles of compounding and discounting. These principles
have been applied to find out the effective rate of interest, future value of money in hand and also
the present value of money to be received in future. This chapter, by relying upon these principles,
is meant to discuss some of the important a.reas of 'applications in the world of business finance.
These areas' of applications include inter-alia computation of annuities, depreciation of assets, as also
the determination of depredation rates, amortization of loans, valuations of bonds and debentures,
and determining the recurring investment to accumulate a sinking fund for use in future.

12.2 MEANING OF ANNUITY

An annuity is a periodic amount of money that is paid at regula.r interva.ls. As a contractual financial
product, it ,is offered by financial institutions, which accept and grow funds from individuals and
after annuitization, pay annuities at a later point in time. The period, during which the fund is
collected and allowed to grow is called accumulation phase and once payments commence, the
contract of annuity is said to be in annuitization phase. Life insurance companies and investment
COlllpanies are finan~ial institutions, which offer annuity products. Individuals seeking stable
and guaranteed retirement income, normally opt for annuities as appropriate financial products.
The pension-benefit and social security schemes are other examples of lifetime guaranteed annuities
that pay the retirees a steady cash flow till they are alive. Hire purchase agreements, leasing
agreements and repayment of loans by instalments are wider areas of application of annuities.
The mechanism of annuities can ·also be used to turn a one-time lump sum payment into payments
of smalle·r denomination in future for convenience.
1111 •us!Nn l

,.
12.2
12.3 TYPES OF ANNUITIES: PRESENT AND FUTl!~E V~LUES , , ~ _
~ .
. ,trate, suppose an annuity of five years with
~ ntracted at interest rate of 6% pa th . annual payment
To 11118 at , 1,000 of the end of each,
,2.3
respect to . · ·• en, ,ta amount (or future value) at the end of fifth
There a~ ~ve types of annuities , which_ differ f~m each other with c . thetr inh year c~ be as shown in Figure 12.2.
r ·~
character1st1ca. These are ordinary annuity, annuity due, deferred annuity o11;tinuoua .~~It year sha
and perpetual annuity. Let us discuss to understan d each of these annuiti~s
charaoteristica, computations and application in business finance.
th
wi respect t~i 0
I
1
I
2
I
3
I
4
I ~
S
i ~
1000 1
.
12.3.1 Ordinary Annuity . , s _ 1000(1.0S)" • 1000.00
An ordin..-...., annuity ia a aeries of payments (or receipts), which possess the three charactel'lat' ► S = 1000(1,05)1 = 1050.00
,
,. ' · 1CI _
as stated below: 1102.50
- - - - - · · Ii• 1000(1.0S)' •
• Amount of payment (or receipt) ia the same in series. 1
the same. ► Ii• 1000(1,05)' • 1157.63
• The intervals of time between any consecutive payment (or receipt) is
end of each period S • 1000(1.05)' = 1215.51
• All payments (or receipts) constituti ng the series are made at the Future Value of an Ordinary Anruty ~
or present valu-~.
The applicatio n as~ts of an annuity involve the computat ion of future
1 ,
Figure 1U
Future Value of Ordinary Annuity
value that accu ul By formula: S = R x S;;i ,% = 1000x~5" =1000x5.52563125 = ,5,525.64
Future value of annuity, also called amount of an annuity refers to the
ded till~ ate, at
the end of term of such annuity. This is the aggregate amount that is compoun e eod of The value of Ss15% = 5.525631 25 may be obtained from the FVIFA table.
ion:
its duration. Let us consider the following tjmeline to understa nd its computat future value through the
, then 00 the . Let us understa nd the dynamics of ordinary annuity in relation to its
~uppose R ~ayments are made for n num~r of years at r"/4 compoun ded annually tiiae examples that follow.
line the senes of payments can be as depicted as under: 4 years. The necessary
n-2 n-1 n Yearend Es:ample 12.1. A company requires ,50,00,00 0 to replace a machiner y after
0 1 2
amount may be accumula ted by investing regularly at the rate of 12% p.a.
Find how much investme nt
basis so as to have the
R R R R R Annuities must be made on (i) monthly, (ii) quarterly , (iii) half-yearly, and (iv) yearly
z.uired amount at the end of 4 years.
I L R(1 +r)
Solution:
Let S;a,.,. be the future value of annuity for n periods at r interest rate
per period, then equated
~ R ( 1 + r )2
periodic instalme nt per period is
+ ,y,-2 R = Amount
'----------♦ R(1
S;;i,,.
'------------► R(1 +,y,- 1 ding to which
Figure 12.1 (i) Monthly basis: We have r=12%+1 2=1%=0.01 and n=4xl2= 48, correspon
for (n -1) years; the 2nd S;a,,. = 61.22260 777 (as per FVIFA table). Applying above formula, we get
The 1st payment made at the end of lat year compounds to R(l + r) -1
11
- 2) years; the (n - 2)th
payment made at the end of 2nd year compounds to R(l + r) - for (n
11 2
R = Amount_ 5000000 = 81669_18
l)th payment made at the
payment made at the end of (n - 2)th year compounds to R(l + r)2; (n - ~... 61.22260777
the end of nth year does
end of (n - l)th year compounds to R(l + r) and the last payment made at
not compound and its value at the end of period remains unchange d. The
sum of all the compounded
(i,) Quarterly basis: We have r = 12% + 4 = 3% = 0.03 and n = 4 x 4 = 16, correspon ding to which
payments (denoted by S) is expressed as below: S;a,,. = 20.15688 130 (as per FVIFA table). Applying above formula, we get
S = R + R(l + r) + R(l + r) + ... + R(l + r)"-2 + R(l + r)n-1
2
= Amount = 5000000 _
248054 25
This is a geometri~ series, which results in the following summatio n: R S;a ,,. 20.15688130
(iii) Half-yearly basis: We have r = 12% + 2 = 6% =0.06 and n =4 x 2 =8,
S = R[(l+r)" -1]=R[(l +r}4-1] correspon ding to which
(l+r)-1 r
S;;i ,.,. = 9.897467 91 (as per FVIFA table). Applying above formula, we get
The above formula computes the amount (or future value) of annuity R being the series of paymenll _ ~ 5000000 = 505179.71
~
that have been compounded at the r% per pen'od 1or b f '. d
R- 9.89746791
n num er o peno s. R.
~
""ii"'
. II d h F t V Jue of Interett (iv) Yearly basis: We have r = 12% = 0.12 and n = 4, correspon
ding to which S;;i,.,. = 4.779328 00
Further the expression [(l + r )" - lJ is denoted by -,.,," and 1s ca e t e u ure a
r , (as per FVIFA table): Applying above formula, we get
. . . d given 11
Factor Annuity (FVIFA), for which d bl 1046172.18
a ou e Prec1s1on table has been compiled an .:._ Amount= SOOOOOO
-..,""
Table 6. Accordingly, g =Rx !L
. R rate rl
R - R.
"',ii"'
4.779328
Uaing the above formula amount of annuity
be ob~~ed, given the periodic pa~men: r'a giftD or, 10,46, 172.18 respectiv ely
interest rand number of periods n. Simi] 1can Therefore, an equa~d amount off 81' 669.18; , 2,48,064 .26;, 6,06, 179.71•
future value of annuity 88 well. er Y, the penodic payment R can be obtamed 0 ne d8
e to be invested on monthly, quarterly , half-year ly or yearly baal8.
 ,... 'I
~.__1'..
~~:i;;;-lJ~:~---~~--7--=-~--------~E:!!i
12.4 BUSINES ' ..,,urr1es ··•
88 8
Enmple IZ.ll. A man require• 1!'20,00,000 to purchnsoa a house after 6 ycor • Ho hoa an n k - ~
to invest the funds in an account which con eorn 6% p.o, compounded quarter! ~n ol>Port 5000 • 12.5
6 ho•• Ill : ~~; ~•500[(1.l)'0 ·: Sum of a G.P series: a + ar + ar2 + ... + a,•-•
must be deposited in each quarter so as to have tho roquirod amount ot tho endy,ofFind ' ff
(Delli/ Uniu. 8 C Yeare llq (l.1)-1 1.1
' . om. lfo,..·
., 2ooti
11
{ a(r·-1)
. = - - - , r>l
.I ... r-1
I
Solution:
Let S
.
be the future value of annuity for n porioda at r mterest rote per period, then ~,,,5ooo[c1.1>' - 1]
0
-u . ,
5000 (.
l• I .' .
I
..J
period11c"'instalment per period is · equa~ :=> 11 ' ( ,,,
R = ~ ; w e have r c 6%+ 4=1.6%= 0.015 and n=5x4 = 20, .. ~ ,. 5000((2.59374246)-1]-4545.46 = 7968.71 - 4545.45 =,3423.26°
:=>· 11
✓ S;a,,.
S = 3423.26><11 = 37665.86
corresponding to which s;i,." = 23.1236671 (see FVIFA table). Applying above formula ' we Ret :=>
. 'ore • balance accumulated at 10th birthday shall be II' 37 •655'86
. ; •·
( ~ There" 1
_ Amount _ 2000000 = 86491.47 pie 12.5. At three months intervals, Mr. Ramesh deposited , 1,000 in a savings account
R - ~ - 23.1236671 E~~
' amount , 20,00,000.

..,jijlUtl
Therefore, ,a6,491.47 need to be deposited every quarter for five years to accumulate the r .
.
equl!td

credits interest at 12% per annum compounded quarterly. The first deposit was made when
w ,c sh's daught er was born and the last deposit was made when his daughter turned 12 yeara old.
R:m:oney remained in the account, compounded quarterly and was presented to the daughter on
here l6th birthday. How much did
T she receive?
E:rample Jll.3. At six-month intervals, A deposited U00 in a savings account which credit 10 Solution:
at 109' per annum compounded semi-annually. The first deposit was mode when A's 80 s 1ereit
months old and the last deposit was made when his son was 8 years old. The money re n ~•• alt Let s be the future value of annuity for n periods at r interest rate per period, and R be the
the account and was presented to the son on his 10th birthday. How much did he receive. in,aine<1 iii deposft' per p eriod then amount accu mulated shall be as shown below:
(Delhi Uniu., B.Com. Hana., 1998, IOI Amount= RxS;;i,,.
Solution: ~ We have r = 12% + 4 = 3% = 0.03 and n = 12 x 4 + l = 49, corresponding to which S;;i = 108.54064 785
(as per FVIFA table). Applying above formula, we get •"'
Let S;i,.. be th~ future value of annuity for n periods at r interest rate .per period, and R be
depoSJt per penod then amount accumulated shall be as shown below: the
Amount (on 12th birthday) = RxS;a,,. = 1000 x 108.54064785 = 108540.65
Amount = RxS;a..,. Since amount of 11' 1,08,640.66 remained deposited for another three years,
J We have r=l0%+2 =5%=0.05 and n=8x2=16, corresponding to which _-, ( 12'¼)"'
Amount (on 16th•-birthaily) = 108540.65 1+7 =108540.65xl.4257 61=154753.03
S;a,.,. = 23.65749177 (as per FVIFA table). Applying the above form ula, we get ··, 1.·
Therefore, his daughter received II' 1,64,763.03 on her 15th birthday.
Amount (on 8th birthday)= RxS ;;i,,.= 100x23.65749177 = 2365.75
~ . . . ,:,• ,;:. ·tJJ:-,--:- Present Value of Ordinary Annuity J
Since this amount of 2366. 75 remained deposited for another two years,
Present value (or currimt :value) of annuity, also called capital value of an annuity refers to the sum of
Amount (on 10th birthday)= 2365.75(1+ l~%J = 2365.75xl.2155062 5 = 2875.58 the periodic p·a yments eacli discounted at the given rate of interest to reftect the time value of money.
The present value' of an annuity is
2 n-2 n -1 n Year end
:J
the all\Ount which if invested at the ., • O 1
Therefore, his son received II' 2,875.58 on his 10th birthday. start of first period at the given rate
of interest will be sufficient to pay R R R R R Annulllft
Example 12.4. Mr. X deposits in his son's account II' 500 times his son's age at the end of each
birthday. Find the balance accumulated at the tenth birthday, if the rate of interest is 10% per off each of the annuities out of such -
annum compounded annually. (Delhi Uniu., B.Com. Hana., 2(/1)() investment as and when they become R(l + it'
due. ' ·
Solution:
The , a.ggregate of annuities duly,• ..., R(l + tr'
Let S be the amount on 10th birthday, r be the rate of in~rest, and (i = l , 2, ... , 10) be the vari0111 discounted till the e.n d of ita duration .,
birth years, then deposit on each birthday ia D; = 500 x i. Accordingly, gives the present value of such R(1 + ,t<n- _ _ _ _ _ _ _ _ ___,
10 JO-i ' annuities. Suppose R payments are
S= 1;D;(l+r) . We haver= 10%, D; = 500, 1000, 1500, ... , 5000. made for n number of years at r% R(1 + ,t(•·'l
M -
~is~o\lnted annually, then on the R(1 +tT" _ _ _ _ _ _ _ _ _ _ _ _ _ ____J
⇒
1 7
S=500(1.1)' +1000(1.1) +1500(1.1) + ... +4500(1.1)1 +5000 ...(II time line ·the series of payments can Figure 12.3
be depicted as in Figure 12.3.
Dividing Eq. (1) by (1.1), we get
'I'he''!:sfpayment made at the end of 1st year discounts to R(l + r)- ; the 2nd payment made at the
1
~ = 500(1.1)
1
+1000(1.1)7 + 1500(1.1)1 ••. + ~
1.1
•••(2) e?d of 2nd year discounts to R(l + r)-2; the (n - 2)th payment made at the end of (n - 2)th year
1.1 discounts:to R(l '+ r)-{n..21; (n.:.,"l)th payment made at the ~nd of (n - l)th year discounts to R(l + r)-{n-ll
Subtracting (2) from (1), we get ~d the last payment made at the end of nth year discounts to R(l + r)-n, The sum o{ all the
discounted payments (denoted by P) is expressed as below:
s(1 - 1\) = [ 500(1.1) + 500(1.1)' +... + 500J- 51~~
1 +._;,, 4 ,,. ~ 1 Jr # .1 ,-, · J': ~ -\ .,,·t: -l't ,,_ _ . .
p = R(l+rf' +R(l+r)-1 + ... +R(l+ry<•·ll +R(l+r/•-•> +R(l+rr•
- .., I --
 .... ---.....
'■
~~~~ ,2'
~
ITT J
Th•• I, a ,cr,omctric terie9, wh.ich ruuJIJI in the faJJo<,nr.g J UIDJDJl.tion: ~ l . 7. Eanunp ah« t u . ~ •Tirl«t • Jlra6W fna 1 -
~ ~
a,11rlmJP ..,.,. t:~-'
~~ ■o'•P
~
f l.OD.QnO 11111 aft-« bao .,. ....,.,1. • •• !,1t1
~
00o per ,_,-. The madll•
•[J-(l+r)•] Rrt-CJ+r)"] can be 1%1acle for lhu &mount JlCral:.J. 111 f'Cl\lAl 1.nnuai inml111f'Tlta ,t NI A..,,.... •fl"""'
~
t,e f
p • R(I ♦ t) I - 0 +r/ r
• ,. ,oP of tht loo. ~ d - - - ~ , '"'1
.d bl.lance llladii"-, 11""' I.hat o.,. - •• 211-'lf-4'
t!Jr anpal I~"- l'•w. It 0 ,..._ H,,.._ zr,nlll
Tho t,ovo Connula compute• the pre111,nt value of an null)' R. being the ..mes '1f P•YDL"'nt,
~ ht"" ·on:
~
1
1,,cc,o compoundi,d nt r% ,,.: r pi,riod (ur n numl141r <Jf pPriod•-
~
s,oluU ha• of 11111cb10e iJI to 6nallCed br ubn1 • 'k!e.11 equal bl the m,r1. r( m•<hm~. "'.,.
further the erpret aitJn: jJ lW pllll't
20()000: r :: 69' p.a. end 11 = 5 ,-....,.._ f'qllal..t lllJluel 111~t.almPnl IEAil rof the l""a u
[
I - II +r)'' ]• I, dcnowd by a-;'" e ntl 1.1 u lfod the Prueol Value of Jnterut Factor .\n
r ••it, bl7 EA.I : !'rinoJ,aJ - ~ - 4i47'i! lll!
- a""' 42l.l.~4
1', , 'I
(l'VlfA), for which o doublo pn-ci.1111/n t1Jhle h,u be!!n compiled ■nd gi,·en H Appt,nda 7. Aax.rai instalment ~f loan, ■mC111nllnf to, 4i.471128 uc.,,.t~ 1.nPf 1.11.11:,.. o(
ia nol adrisable to purch■f'f the mr.chine
the eurun¥!
I' • R it o .,.. llr}y, 5.uice tb•\t nnual
Mr. X Rlla his old car for f 1.00,~ Lo bu:, a new °"" cn-tm1 , 2.511.(l(l() He ~•:i
,rtJ•ca1b . 9"'balauc■
' .,:;,OOo,e
19 1 I I .&
U1in~ ahovo furmulu , tho pro•cnt vul uci ,Jf 11onu1ty uin b<: 11hLa.m ·d given lhe annuity and
1
P d ~ment of f i .000 1t lllf end of ._, b month rot 11! month•. If ll•e "
annully cun Lu ohloincd fur o given 11r•i11t•nt vqJue c1.;rre•11ondmg lo ,uch annui ty for a gi ll.milar!y ··).,. ~ D ll"4J'WI
lnt-0rc1l nnd numl1or 11' purh,d• . Tu 1llu•Lrot.lJ, suppoae on a nnuity of five yrera with ennu:to :•Lt
ri Ill
per 1.nau.m compounded monthly, 6nd .t. s,wn th111 (I 00, ., • ' · nd • ....,.
oft 1,000 of thll end cocl1 yco r 111 c1111Lr11rt,•d 11 anv:re1t rat.e of 5•~ p.a . LhPn it.a current ( P ~
(l)p/A1 l'""• IJ Ca .. IJ....,, . 1111/J. tlllf lJI ,,~ ,1
or b,te.-.l lJ
Solution:
11oluo) In Lhll l11•11innin11 of fir•l yr.n r • holl I.Ii! u 1bown beluw: or Pl'l!llf'llt 1- 0•r) '
.
2 3 • 5 n,e preaent 111lue of 11nnu1ty 11( , I • a;... • r • wh""' , • """ 11( int,.r-t 1.nd 11 = numl'f'T
0 I
1000 1000 1000 1000 1000 tfperiodl• We hav-a r • 9'14+J2.,0.i~" • 00075 pm. ind 11., 18 month!.
}Jler aelling old car, the amount required to bu7 new car i1 C.1.£>~.llOO 1.00.000) = f l.1'>11.00()
~
1000 Q
(10~ -1ma11
1000
Sml'e thi• 11mount ia paid partly In ca■h and p1rtly b1 ln•lAlm,nta.
(100)' • 1107 03 Balance payable • Down payment + r l'l!11enl •alue of m•talmen~
1000
l10G)1 • ooa ro l6!5000 • J ~,ooo .. °i~n.. i:, 11\NJCJO a H 1000(' ~n ;·1 • )
1000
- - •82HO
11 oor 7n00( l - /1 0•OCWJ,;;1 '• )
=> 1r,MOO • J., OIJi0
1000
~ , · •1"3.53
,-.., 1i,IIQOO ■ ,I ♦ 7rNJQ •
l - 011'141~i! )
P~■-nl Value of 11n - (
Ordln•l)I A1mully • •ne.•e 0 f~l iG
flgu,. n.•
⇒ lf,lll)O(J • • • 7000 • Ill ~7111111
Uy rorn1ulo: P • R " o,1,,. .. 1000 ,w..,,,. • 1000~ ◄.3294 71'!07 • f ◄ ,329 ◄ A => JGl!IJOO• .n llit:'.U7
Tho vuluc or o.,.. • 4.32047007 mny lw ohLA11wd from LhP PVWA tohl,-, ', 1 , ·-4 •r tt-, lr• ..uu.
=> J • I r,IIIJflO- ll 74:"lC 27 • 4ot,,;; 73
Let u, undur~tnnd lho Jynomic■ of ordinnry Annuit y in !'<'lollon lo It ■ JlN.•-••nt value through• ll'MN
Tbm!fore, lhr ini tial down payment u r • , •0.64-~ 7i.
or 111nmplce lhol follow.
Euni11l0 I 1.6. M.r. l l111n11nl huye o new houec for f ◄0,00.000. In d1wharg1• of pur<'ha&c roMidenuon. Enmple 1%.9. What would be th• monthly 111n 't'Vlume ol • cnmJ>l/11 If 1l d.,.,11!1 to ~u11 a
ho 111nkc1 11 duwn poymrnt nnd owrt•~• Lu pny thl' halon~ by inatalmrnta of f 3,00,000 11 the f'D• IN annu■I n-tum mn¥t'r11b1e 111onthly on It• 1n•...tmP11l of '2,flO,IJOIJ" M""thl1 ro,IJ a.r• ' ~.ono
of each quurwr for 3 Y<'DTI, If lho roll' of intmi•l i, I 2'l. p.11. compounded quarterly, 6nd out tht Thi! lnvenml"nt 11,ll la•~ cieht ~•~ Wt with no acnp ,·,tu.. u,-111J 1.:•.,,. /I ('0111 " - . ,.l(IJ. IM:'IC" C' ll
/
1m11unt of down pnymunt, Soluilon:
\) Sulutlont ut 1u auume Lh11t the monthly ulH volume • , .c.
l .t•l r be r•te of lnlC!l"l'al ond n be 11umb1•r of period, . then prc6<'nl velut' of annuil)' of ' l = .,.
0
1 Civta llat pnnopa.l P c 200000, • •
■nd t:l'I • t:quat~d l'l!rioJJc ln1talmrnl:
Pfnod n = 8 x 12 = 00 montha, and rate,• 12-. • 12 • 1, p.m.
l'N>•Pnl valul! crV) of f111tolment1 c, EPlxo,, ... ; fhto' i.. vl tT 1. ,,.
Wo h■~ n • 3 • ◄ • 12, r• 12~ • ◄ ., 3~4. a,,.,.= 9.96◄00399 and EQI :: , 3.00.000 200000 • lir - 300<.IJ•G•\ot ID u -WJ0, ■ 6U21'702llll • 200000
Act.'Ordi1111ly, pr.•111<111 value of J::QI • El'l11 0,1" = 300000 l< 9.95◄00399 = 29.86.201
:) I l't -aooo 2/lOOOO O .t•Sl50.37 • :,ooo "8360.67
Diown p■ym~nt • C'111t uf ho~c - l'V of EQJ 6 l.52770:/119
• ◄0.00,000 - 29.l!0,201 • 10,13,799 ~refore., £he required monthly uh,1 volu~a u U ,2!,fl.&'7 I'>"' ni11"th,
Tht•rt•fore, tho du•n paynu,nt m■dC! in diM'h.or~e of purchase oonsidl'totion is , 10,13,799
l1
 'P
'·
BUSINESS MAT............ ~ 12.9
You have just won a million .rupees; the prize is awarded in 10 annual ~
12.8 q
-=:::::!.._
·
E:s:aJDP1e 12.10. . d th d f h y . P8Y1Ue11•• 50Jut1on:
off l,00,000 each. Annual payments are receive a~ e en o eac . y~ar. ou are given the O ... 1.,et us compute his yearly income from photocopying.
to receive single Jump ~um pay':'1ent of !6,00,000 U1stead _of the milh~n rupees annuity. You ~tion
to find out8 which option more Ill todays rupees. Money IS worth 10¼ ~om~ounded annually II.lit ~evenue = No. of pages x days x (charges per page) = 3000 x 360 x 0.6 = 6,40,000
18
•• - _ ·- -,, •• -7: (Delh i Uniu., B.Com. Hoh• ~ . k d _ No. of pages x days
• ...: ...., ~. .a. '•' ' • • ·-·· •008) cost Of toner inuse - Pages per toner cartridge x Co8 t per to ner
Solution: . ,._ ~ , ..: - ., ,. ·."
Let r be rate of.interest and n be number of periods, then present value of annuity of . ,. · 3000x360 '
X 500 = 1,08,000
·· .:.:.· . ~-. ' •. 1-(l+rf• 5000
,1=a,;.,.= r Income ::: Revenue - Cost = 6,40,000 - 1,08,000 = , 4,32,000 per annum.
We have r-= 10% p.a. and n = 10 years, accordingly the present value of 10 annual payments Let r be rate of interest and n be number of periods, then present value of annuity of , 1 = o;a..,.,
f 1,00,000 each may be computed as under: of and if EAI is equal ·annual income, then present value (PV) of future stream of income,
P=l00000 xa..i._10 =100000 x6.14456711 = 614456.71 . ,
PV = EA1 X a.,,,.
Since the lump sum payment of f6,00,000 falls short of present value of 10 annual payments b
f 14,466.71 that is (6,14,466. 71- 6,00,000), the option of 10 annual payments off 1,00,000 We haver= 9% p .a., n. = 6 years, EAI = f4,32,000 and a.i.,. =4.48691859.
each is bette;,
E:s:ample 12.11,· Mr. X purchases a house for f2,00,000. He agrees to pay for the house in 6 Accordingly, PV = 432000 x 4.48591869 = 19,37,916.83
1
instalments
. at the end of each year. If money is worth 5% p.a. effective, what would be the size ~quaf
o Therefore, the investment is worthwhile because the present value of future stream of income
?ach U1stalment? In case Mr. X makes a down payment of f 60,000 what would be the size of each· amounting to f 19,37,916.83 exceeds the initial investment off 10,00,000 in photocopying machine.
mstalment? _ _ __ - · _____ _ . (Delhi pniu_.,,_B.~f!!,.&n~.,_2~!!1
Example 12.14. A company wishes to invest fl0,000 in a machine that will yield an income
Solution: . •· " . , ... · - - stream of f 1,200 per year for the next 8 years. If money is worth 8% p.a. effective, find whether
Let r be rate of interest and n be' number of periods, then present value of annuity of fl= ~ the investment is worthwhile. (Delhi Uniu., B.Com. Ho,..,, 2011!)
_---_ .EAT~~-:_
and equated annual instalment,
;: · ·· · •
due.;.---·------~-----·~· .. --.c.--- ,--· __ 0
Solution:
Let r be rate of interest ,and n be number of periods, then present value of annuity of , 1 = a~,
and if EAI = equal annual income, the present value (PV) of future stream of income,
We have oslo.os = 4.32947667 and amount due= f2,00,000. PV=EAixa..,.
Accordingly, when no down payment is made, We have r = 8%, n. = 8 and EAI = 1200.
EAi _ 200000 _ 46 9 4 96 Accordingly,
- 4.32947667 - l ·
PV = 1200 x 5.74663894 = 6895.97
When a down-payment-is made: (down payment being '50,000),
Therefore, the investment is not worthwhile because the present value of future stream of income
= 200000-50000 150000 = 34646.22 amounting to f 6,895.97 falls short of the initial investment.
EAi 4.32947667 4.32947667 . _ --· E:s:ample 12.15. Machine A costs f25,000 and bas a useful life of 8 years. Machine B costs t28.000
Therefore, size· of instalment is f46,194.96 when down payme~t is not ;~d-~ a~d ~34,646.22 when and has a useful life of 6 years. Suppose Machine A generates an annual savings of , 5,000 while
a down payment is made. machine B generates an annual savings off5,500. Assuming the time value of money is 7% effective.
E:s:ample 12.12. A company wants to buy·a machine for f 1,00,000 that will yield an income stream which machine is preferable? (Delhi Univ., B.Com. Bona., 2018>
of ,6,400 per quarter for the next 6 years. If a loan can be obtained to buy this machine at 12% Solution:
p.a. compounded quarterly, find whether the investment is worthwhile or not.
Machine A generates an annual savings of ('5,000 over useful life of 8 years, accordingly,
So~~tion: . ,. . , .• , .: ._. , . ._., • ,;1,;.,, d Present value of savings generated by Machine A = 5000(oel.07 ) = 5000(5.971298) = 29856.49
Let r be rate of interest and n be number of periods, then present value of annuity off 1 = a;.", an Thus, the present value of the eavings generated by Machine A is t 29,866.50.
if EQI is equal quarterly income, then present value (PV) of future stream of income, PV = EQi xo;;}il Net savings from Machine A = Present value of savings - Cost of machine
We have r =l2%+4=3% p.a., n=6 x 4=24, EQ1=6400 and awo.oa =16.93554212. = 29856.50 - 25000 = 4856.50
Accordingly; PV = 6400 x 16.93554212 =108387.47 Net savings from Machine A amount to t 4,856.60.
Therefo~e, the investment is worthwhile because the present value of future stream of incoine Machine B generates an annual savings of ('5,500 over useful life of 6 years, accordingly,
amounting to II' 1,08,387.47 exceeds the initial investment. " Present value of savings generated by Machine B = 5500(061.0 7 )= 5500(4.766540) = 26215.97
E~ample 12•1~· ~ person is contemplating to install a photocopying machine at a cost oft 10,oo,~O J Thus, the present value of the savings generated by Machine Bis f26,216.
; 1th 8f productive life span of 6 years during which the machine is to be maintained by the supplier
ee ~ c~st · He knows that on an average, he can photocopy 3000 pages per day and charge Net savings from Machine B = Present value of savings - Cost of machine
6o paise ,or each page from the
in

t
8 Pyear

ff to
cus mers. The toner cartridge
.
needs replacement after 5000 pages
:iie• ~:h:. 500. P. loan c~n b_e obtained to buy this machine at 9% p.a. effective, find out whe ther
ro:;~t~:Y:achme 18 worthwhile or not, assuming that the machine will be put to use
i = 26216 - 28000 = -1784
Net savings from Machine B amount to - f 1,784 ,
11
I Hence, Machine A is preferable. 1111 11
 1210
·
• l 8 A person orrow
b
•
·• •" 110 000 nt 0% compoundlld nnnuolly
' •· · •
to bo t•p
BUSINESS MATHE
• &Yab( .
e 1n
~
• ,.,,-,u1r1es
~ l u e of EMI = R " o;;i,, A1 wo have R 5000, r 12% + 12 =
• 26.807708. Accordin11ly,
= =
l% 0.0l, and n. =
12.11
=30,
Example h, · . enta ,t the end of each ycnr. Howovcr, nt the time of 6th inetal I'
1 tho occo lllent the then a3010.01
8 equ11ed annual mshL mff the loon How much ehould be pnld by him to settle
individual electt to pl\)' 0 •
Unt? vehicle = PV = Rx 0 aiiki.01 • 6000" 25.807708 = f 1'29'038.54
co1t Of
Solution: t = '1,60,000 - '1,29,038.54 :: "20,961.46
• t •• and n be number of periods, present vnlue of nnnuity of • 1 a-,
( · I d PV · ' = intere1
of 111 ereo, '20,961.4 6.
Let r be nterinciplll
_, to amount. EAi d,motcs equal annun msta ment, an 18 tho present !'11
\>a(u 8 'J'hereforc, payment towards vehicle i1 f 1,29,038.54 and toward, interest i1
P nnen P
(PV) of instalments. Annuity Due
=8; p =250000• then os per PVIFA tnblc aiibl, = 6.634819 11 end accor ding]y, 32
12. · . .
We hA\'I! r -_ go,; P,I •• n · character istics as
AD annuity due 18 a sen cs of payments (or receipts), which posae11 the three
p 250000 ,tated below: . .
EAi - - • ---=4 5168.59
- °i.,,. 5.53481911 • Amount of pnyment (or receipt) 11 the same in aerie,.
The PV of 5 instalments paid, PV = ~ x EAl = 3.88965126 ~45168.69 = 176690.08 • The intervals of time between any two consecutive paymenta (or receipts) is the same.
• J\]) payme nts (or receipts) constituti ng the aerie, are made at the
beginning of each period.
PV of unpaid principal = 250000 - 176690.08 = 74309.92
The application aspects of an annuity involve the computation of future or present value.
LetA. be the amount aner n periods, then A. = P(l + r)•
We have P =U309.92, r =9% p.a., n =6, then FVIF =(I + r)• = 1.67710011. Future Value of Annuity Due
refer, to the value that
Future value of annuity due, also called amount of an annuity due
Accordingly, •.\,, = P(l + r)• = 74309.92 x 1.67710011 = 124626.17 ccumulate s till the end of term of such annuity. Let us consider the following
timeline to understa nd
to settle the account. year for n number of years
Tberefure, an amount oH 1.24.625.17 needs to be paid et the end of 6th year ~ts computation. Suppose payment R is made in the beginning of each
can be depicted as in
of fl per annum i ~t r% compounded annually, then on the time line the series of payments
Eltample ll!.17. U the present value end amount of an ordinary annuity
n number of years are f8.1109 and t 12.0061 respectively, find the rate
of interest and the v1J°r Figure 12.6.
ue O 1 2 n-2 n-1 n v-erld
of II without consulting the compound interest table.
(Delhi Univ., B.Com. Hons., 2002, 2004, 2008, 2011) R R Annuities
R R
Solution.:
Let r be rate of interest and n be number of periods, then present value
of a nnuity of , I =
As we know, °"1r11
I LR{,.,,
and amount of annuity of 5;;i,,_. We have a;;i ,% = 8. 1109 and S;;i,.,. = 12.0061. ~R{1•t'f'
I l
r = - - - - -, therefore ~ - - - -- - - - ---+R{ 1 +,r-•
a;;,,,. S;;i,%
·
~-- - - -- - -- -- - --R(1 +,r
I I
r =8 _1109 - 12_0061 =0.123291 - 0.083291 = 0.04 =4% Flgu,.12.5
r)" for n years; the 2nd
The 1st payment made in the beginning of 1st year compounds to 1R(l +
- l) years; the (n - l)tb
We al.9o know that S;;i,,. =
(1 + r)" -1
r , therefore payment made in th e beginning of 2nd year compounds to R(l + r)• - for (n.
payment, being the last
payment made in the beginning of (n - l)th year compounds to R(l + r)2; nth
of all the compoun ded
payment, made in t he beginning of nth year compounds to R(l + r). The sum
(1+0.04)" -l
12.0061 = 0.0 4 o 12.0061 X 0.04 = (0.04)" - } payments (denoted by S) is expressed as below:
1
S = R(l + r) + R(l + r) 2 + ... + R(l + r)"- + R(l + r)"
⇒ (1.04)" : 12.0061 X 0.04 + } : 1.48
⇒ n log(l.04) = log(l.48) This is a geometric se.r ies, which results in the following summatio n:
⇒
n = log(l.48} = ~ = IO S = R(l+r)[(l+r)"-l]= R[(l+r)" .i _(l+r)]= R[(l+r)" '1-l _l]
log(l.04 ) 0.0170 (l +r}- 1 r r
Therefore, rate is 4% p.a. and value of n is 10 years. the series of payments
The above formula computes the amount (or future value) of annuity R, being
per period for n. number
Example ll?.18. An automobile advertisement reads: "No money down. 6000
interest rate equals 12% per year compounded monthly on unpaid balance."
per month for 30 mo;~
How much of
that o:iolo.oi = 25.SO C))
'1,; 708
made ~n the begi nning of each year, that have been compounded at the r%
of periods.
to be paid will go for interest and how much for the vehicle itself? Given Furth er the expression:
Solution: (Delhi Univ. , B.Com. Hons.. 200T(C. .
[
(l +r)"•
r
1
-1] is denoted by 8..i, ,%·
I Let R be tbe EMI, r the rate of interest per month, n be the number o{ monthly
instalments, then
~ ,_,,, '"" """"''""."a,· Accordingly, S = R(~ -1)
... .....n+ll r'4
 12.12 BUSINESS MATHEM
• NUJTJES 12.13
.
~ t
To illustrate, suppose an annuity of five years with annual payment of "1,000 i t h ~ ~ y m e n t s are made for n number of years at r% discounted annually, then on the time
each year is contracted at interest rate of 5% p.a., then its amount (or future v begillnin Suppose . of payments can be depicted as under:
be series
fifth year shall be as shown Figure 12.6. or 6
a ue at the endhr )i!l t O 1 2 n-2 n-1 n Y-end
2 3 4 5 I I I I I I
j ~ R R R R R Amuiliea
t j
T'i
I-
.J I
1000
10001 101.. .,.,000,..,•. '°"'-"'
► S =1000(1.05)2 =1102.50

R(1 +r,1
R(1+r,2__J
L.---------► S = 1000(1.05)3 = 1157.63 R(1 + r)-,n-21 ----------..J
'------------+► S =1000(1.05)' =1215.51
R(1 +r)"'n-11.-_ _ _ _ _ _ _ _ _ _ _....J
'---------------+ S =1000(1.05)' =1276.28
Future Value an Ordinary Annuity Due = 5801.92 Figure 12.7
Flgu,-12.6 The lst paym~nt made in the ~eginning of 1st year remains the same at R; the 2nd payment made
. the beginning of 2nd year discounts to R(l + r)-1; and the nth payment, being the last payment
By formula, S = R(S~-l)=lOOO(SS+ils" -1) :ade in the beginning of nth year, discounts to R(l + r)-<•- 1>. The sum of all the compounded
ents (denoted by P) is expressed as below:
paym
Since 5s)
5
" =6.80191281 (FVIFA table), we have S = 1000(6.80191281 - 1) = "5,801.91.
P = R +[R(l+rr' +R(l+rf' + ... + R(l+r)"'•-ll]
Using above formula, the amount of annuity _can be obtai?ed, given the annuity payment due and
similarly annuity payment due can be obtamed for a given future value corresponding to such A perusal of above ~quation rev~als that there is an initial payment followed by an ordinary annuity
annuity due. of R for (ri - 1) periods. Accordmgly,
Example 12.19. Mr. X wants ,5,00,000 at the end of 7 years. If the rate of interest is 8%, what P = R + R x ain-iil '"
amount shall be deposited at the beginning of each quarter so as to get the above amount?
(Delhi Univ., B.Com. Hons., 2007) Alternatively , P = R + [ R(l+rf' +R(l+rf2 + ... +R(l+r)"'"-''] is the sum of Rand a geometric series
Solution: having (n - 1) terms, with first term R(l + r)-1 and common ratio (1 + rJ-1•
ince amount is to be deposited in the beginning of each quarter, it is a case of annuity due. Since, formula for sum of n terms of G.P. with first term 'a' and common ratio 'r' is
A Let r be rate of interest and n be number of periods, S be the amount required in future, then
future value of annuity of "1 paid in the beginning of each year = S;;;u '" -1 and equated periodic
instalment, (EPI):
s
"
1-r"]
S =a [- - r,'1
1-r '
P = R + R(l + rt' [l-(l + r)"'•-•>]
EPI = ~ Therefore,
...,n+ll r" -1 1-(l+rt'
We have r= 8% + 4 = 2%; n = 1 x 4 = 28, and S = ?5,00,000, then
⇒
P = R + R[(l +rf' -(l+rr •-<•-1)]
l
S291o_02 = 38.79223451 (As per FVIFA table) 1-(l+rt '
(
Thus, equated quarterly deposit,
⇒ p = R + R[(l+rr' -(l+rr•
500000 500000 [(l+r)-1)
EQD = ~ -1 S291 ,02 -l (1 + r)
- 28+110.02 0
500000
- 38.79223451-1
500000
37.79223451 ⇒
p=R+ a[ (1 + r)I-I -r(l + r)"'•-l)]
= 13230.23
Therefore, a quarterly deposit of f 13,230.23 needs to be made. ⇒ p= R+ R[1-(1 +,')-(•-•>]
Present Value of Annuity Due
Present value (or current value) of annuity, also called capital value of an annuity refers to th~ su: ⇒ P =R + R xain-iil"' ⇒ P =R(l + af,;:jilr11)
of the periodic payments each discounted at the given rate of interest to reflect the time va ue_od
money. The present value of an annuity is the amount which if invested at the start of fir5t pen
at the given rate of interest will be sufficient to pay off each of the annuities out of such inve9tlllen1 l-(l+r)-(•-11 ]
Alternatively, P=R [ 1+.:,._'---'--
as and when they become due. r
The aggregate of annuities duly discounted till the end of its duration gives the pres_enl
value of such annuities. Let us co_nsider the following timeline to understand its computation. ⇒ P=R [r+l-(l;r)-(•-11 ]
~f'i
 BUSINESS MATH
~12~.14~--------------------..;.: ::.::.::~
(1 + r)[l - (1 +rt"]]
⇒ P=R [
r

⇒ P=R [[1-(l;rt" ]]<l+r)

A erusal of above equation reveals that the above ~s a product of ordina~y annuity of
P . d dt
n perio s an erm (l + r) • Thus , present value of annuity due can also be obtamed by the 11011O'king
R for
formula:
p = R [a;;i , % (1 + r)]
To illustrate, suppose an annuity of five years with ann~al payment of f 1.,000 in the beginnin
each year is contracted at interest rate of 5% p.a., then its present value is computed as follo! of
8.
O 1 2 3 4 5
I I I I I I
1000 1000 1000 1000 1000
1000
(1.05)0
= 1000.00 ~I
1000
= 952.38
J (1.05)1
1000
= 907.03 - - - - ' - - - - - - - -
(1.05)2
1000 = 863.84 _ _ _ _ _ _ _ _ _ ___.
(1.05)3

1000
= 822.70 - - - - - - - - - - - - - -
(1.05)4
Present Value of - - - -
an Annuity Due = 4545.95 Figure 12.8

By formula, P = R(l +a~%)= 1000(1 + as=il5%). Since a 475% = 3.5459505 (PVIFA table)
⇒ P = 1000 X (1 + 3.5459505) =? 4,545.95
Using the above formula, the present value of annuity that occurs in the beginning of the year can
be obtained. Similarly, annuity can be obtained for a given present value corresponding to such
annuity due.
Let us understand the dynamics of annuity due in relation to its present value and future values
through a series of examples that follow.
Example 12.20. You have just won a million rupees; the prize is awarded in 10 annual payment of
? 1,20,000 each. Annual payments are received at the beginning of each year. You are given the option
of receiving a single lump-sum payment of ? 8,00,000 instead of the 1.2 million rupees annuity. You
want to find out which option is more in today's rupees. Money is worth 10% compounded annually.
(Delhi ([niu., B.Com. Hons. , 2008 (Modified))
Solution:
Let r be rate of interest and n be number of periods, then present value of annuity of n received
in the beginning of year = ( a;:i-i , % + 1). We have r = 10% p.a. and n = 10 years.
Accordingly, the present value of 10 annual payments of, 1,20,000 each may be computed as:
P = 120000(al0- llo.1 +1) = 120000 x (5.75902382 + 1) = ,8,11,082.8 6
Since the lump sum payment of , 8,00,000 falls short of present value of 10 annual paymen~
~ amou~ting ?11,082.86 that is (8,11,082. 86- 8,00,000), the option of 10 annual payments of~l,ZO,O
, each 1s better.

I~~xample 12_.21. Mr. ~ p~rchases a house for ,2,00,000. He agrees to pay for the house in 5 eq~;!
\ J i~stalments ~nthe begmmng of each year. If money is worth 5% p.a. effective, what would b~ eaJ)
~ size of each m stalment? (Delhi Univ., B.Com. Hons., 2012 (Modified) 2019 (Modifi
 12.15
,.~n~UITIE~S'.--~---------------------
~
-------
Solution: .
b rate of intere st and n be numb er of period s, then prese nt value of annm.
ty of t 1 paid in
Let br ~nnin g of each year is a(n-l)I r % + 1 and equat ed annua l instal ment (EAI):
the ei,----
Amou nt payab le
EAI=------
n-llT '¾o + 1
a--:11

We have a _
410 05 = 3.5459 5050 and amou nt due = ,2,00, 000. Accor dingly ,
20000 0 20000 0
EAI = 3.5459 505 + 1 = 4.5459 505 = 43995 . 2 o

Therefore, size of instal ment is ~ 43,995 .20.

Example 12.22. Jagdis h Pl!-rch ased an asset for , 1,00,0 00 on instal ment
bas.is. Each insta l~ent
is to be paid at the begin ning of each quarte r. Find the size of each instal ment
if the mone y 1s to
be repaid in three years and the rate of intere st is 6% compo unded quarte
rly.
(Delhi Univ., B.Com . Hons._, 2007, 2015)
Solution:
Since amoun t is to be depos ited in the begin ning of each quarte r, it is a case
of annui ty due.
Let r be rate of intere st and n be numb er of period s, P is presen t value of equat ed
period ic instal ments
(EPI), then pres~n t value of annui ty of~ 1 paid in the beginn ing of each year
is ( an-l~% + 1 ). Accor dingly ,
' / p -
.._/ EPI = (a +l)' As we haver = 6%+4 =1.5% = 0.015, n = 3 x 4 = 12 and P = tl,00, 000,
n- 1! r%
then

°i2-ib..s% = aiih.5% = 10.071 11779 (PVIF A table) and equate d quarte rly instal ment (EQI)
is:
T\ ,J EQI = P = 10000 0
\' (an-llr%+1) 10.071 11779 +1
-~9 10000 0 . -
= 11.071 11779 - 9032 ·51
Therefore, a quarte rly depos it of ~9,032 .51 needs to be made.
 p =
- .i: - C,
⇒
l,
12.3.5 Perpetual Annuity
uity (or perp etuit y).
An annu ity who se paym ents co.nti nue forev er is calle d perp etua l ann
Futu re Valu e of Perp etui ty
it keep s on incre asin g with time.
The futu re valu e or amo unt of a perp etuit y is not defin ed beca use
Pres ent Valu e of Perp etui ty
type s of perp etuit ies:
For comp uting the pres ent valu e of perpetuit:y:, we com e acro ss two
peri od.
(a) Paym ent at the end of perio d; (b) Paym ent at the begi nnin g of
(a) Paym ent at the End of Peri od
at the end, the prese nt value is
Whe n first perio dic paym ent, unde r term s of perp etuit y, is mad e
comp uted · as unde r:
R - R R - nR
P = ( 1 + r) + (l--+ r )' + ... + (1 + r )" = R ~
'
 NNUITIE:::,.S_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _......;,...._1:.:2:::.2:=-3
~ is a GP series in which, we have
Since
P = R lim
n➔co
[f
lc l
1
(1 + r )'
] = R! - R
r- r
I
\

'fbis implies that the periodic annuity value is to be c~pitalised by the rate of interest..
E aJJlPle 12.38. Find the amount to be deposited into an endowment fund that is to be compounded
a:nuallY a_t the rate of 9% p.a. to provide for an annual scholarship of ~27,000 for an indefinite
peri
·od of time. .
I ·'-
I'
solution: 1

1,et p bf•;.:P:::::i::~::;:::::::,::P::i;~;.b:::•::'::::•::•::n~ :.o:•: ~. :::u:~ ;:~~o::~

R 27000 r
Accordingly, P =-; = 0 _09 = 300000 .• ,

Therefore, an amount of ~ 3,00,000 needs to be deposited as endowment.

Example 12.39. The principal amount demanded by a bank to guarantee a perpetual annuity is
reduced by 20% after rate of interest compounded annually is increased by 2%. Find out the rate
of interest allowed by the bank after reduction in principal amount.
Solution:
Let p be the principal amount demanded by the bank, R be the perpetual annuity, r be the rate
of interest before reduction in principal amount, then rate of interest after reduction in principal
amount is (r + 2%).
The principal amount before increase in rate of interest = R .. . (1)
r
R
Principal amount after increase in rate of interest rate = - - - ... (2)
r+0.02

r ⇒ __r_=0.8
⇒ 1 - - - - = 0.2
r+0.02 r+0.02

⇒ r = 0.8(r + 0.02)
⇒ r = 0.8r + 0.016

⇒ r= 0.016 =0.08 = 8%
0.2
Therefore, the rate of interest allowed by the bank after reduction in principal amount is 8% + 2%
:: 10% p.a.
Example 12.4 o. How much money is n eeded to ensure a p_ension of ~ 60,000 at the end of each
Year forever that grows at the rate of 2% p.a., if the money is worth 101/o
0
p.a. compounded yearly.
Solution:
~t P be th • .
0f
e prmc1pa1 amount nee d e d , r be the rate of interest,
•
R be the annuity payable at the end
h h 1 f •
is each y d b h
ear, an g e t e annua1 r ate of growth in annuity, t en t e va ue o perpetual annwty
computed as:
R
P=-
r- g
 12.24 BUS
=-~---------------------------!:'.~l~N '.=:E~SS~M~AT!_!H~E~MA~T ICS
We have R = 60,000, r = 10% and g = 2~. Accordingly, --

p =~ = 60000 = 60000 = 750000

r- g 0.1-0.02 0.08

Therefore, an amount off 7,50,000 is needed to ensure a growing pension of f60,000 annually.
(b) Payment at the Beginning of Period
~en first periodic payment, under terms of perpetuity, is made at the beginning, the present value
1s computed as under: · .
' R R R . R ~
P=R+( )+ + ... +---=R+- ~ J
l+r (1 +r)2 (l+r)" r
This implies that the periodic annuity value is to be added to its capitalised value of annuity.
Example 12.41. How much money is needed to ensure a series of lectures costing ?2,500 at the
beginning of each year indefinitely, if the money is worth 3% compounded annually.
(Delhi Uniu., B .Com. Hons., 1999, 20U)
Solution:
Let P be the principal amount to be deposited, r be the rate interest and R be the annuity payable

at the ~eginning of each year, then the vaiue of perpetual annuity is computed as P,;, R ~ ,: .

/ Now we have r = 3% = 0.03 p.a., and R = ?2,500. Accordmgly, · .,J ·-

p = R + R = 2500 + 25 00 = 2500 + 83333.33 = 85833.33.

r 0.03 .
Therefore, an amount off 85,833.33 is needed.
Example 12.42. How much money is needed to ensure a monthly pension off 60,000 at the beginning .
of each month forever, if the money is worth 9% p.a. compounded monthly. .
1 •

Solution:
I/Let p be the principal amount to be deposited, r be the rate interest and R be the annuity p';i'able
V at the beginning of each month, then the value of perpetual annwty 1s computed as P=R+;•

Now we have r = 9% + 12 = 0. 75% = 0.0075 p.m., and R = f 60,000.

Accordingly, p = R + R = 60000 + 6 0000 = 60000 + 8000000 = 8060000
r 0.0075
Therefore, an amount of f 80,60,000 is needed for this pension plan.
___,;,_ _...:.__ __:._ _..:.__-----'(EXERCISES )r--~~- ;...._--- -~-
Future Value of Ordinary Annuity
1. A company requires f 36,00,000 to replace a machinery after 5 years. The neces~ary amount may
be accumulated by investing regularly at the rate of 9% p.a: Find how much investment must
be made on (i) monthly, (ii) quarterly, (iii) half-yearly, and (iv) yearly basis so as to have the
required amount at the end of 5 years.
2. A man requires f 25,00,000 to purchase a house after 6 years. He has an oppor~unity to invest
the funds in an account which can earn 8% p.a. compounded quarterly. Find how much fuust
be deposited in each quarter so as to have the required amount at the end of 6 years.
3. At quarterly intervals, A deposited f 500 in a savings account which credits interest at 12% per
annum compounded quarterly. The first deposit was made when A's son was three months old
and the last deposit was made when his son was 10 years old. The money remained .in the
account and was presented to the son on his 12th birthday. How much did he receive?
r
t,1t.JUITIES
~ e r a j a deposits in her son's account ~ 900 · ·
12.41

4, ~s- he balance accumulated at the 12 h . times ~er son's age at the end of each birthday.
Find t d e d annua11y. t btrthday, if the rate of interest is 9% per annum
compoun

s intervals, Mrs. Rachana deposited ~ 5,000 in a savings account which credits ·

th
6, At three-mo~
st 9
intere at ¼ pe~ ;;n~m compo~ nd ed quarterly. The first deposit was made when Rachana's
st
son was b~rn :n e a deposit was made when her son turned 10 years old. The money
rexnained m t e acco~nt, comp~unded quarterly and was presented to the son on his 12th
birthday. How much did he receive?
Annuity
present Value of Ordinary
6, Mr, Hemant buys a new house for ~ 60,00,000. In discharge of purchase consideration, he makes
a down payment a nd agrees to pay the balance by instalments of ~ 4 00 000 at the end of each
quarter for 4 years. If the rate of interest is 10% p.a. compounded qua;te;ly, find out the amount
of down payment.

7, Cash earnings after taxes fr~m a new machine are expected to be ~66,000 per year. The machine
costs t 3,00,000 and ~fte~ six years has no resale or scrap value. A loan can be obtained for
this amount payable m six equal annual instalments at 8% per annum on the unpaid balance
of the loan. Should management buy the machine?
s. Mr. X sells his old car for~ 80,000 to buy a new one costing~ 3,50,0Q0. He makes a down payment
in cash and balance payment of ~22,000 at the end of each quarter for 3 years. If the rate of
interest is 8% compounded quarterly, find the amount of down payment in cash.
9. What should be the quart~rly sales volume of a company if it desires to earn a 9% annual return
convertible quarterly on its investment of ~ 4,00,000 in machinery? Quarterly costs are f 9,000.
The investment will have ten years life with no scrap value.
10, You have just won a million rupees; the prize is awarded in 12 annual payment off 1,25,000
each. Annual payments are received at the end of each year. You are given the option to receive
a single lump-sum payment of ~9,00,000 instead of the million rupees annuity. You want to
find out which option is more in today's rupees. Money is worth 9% compounded annually.
11. Ms. Pallavi purchases a house for ~25,00,000. She agrees to pay for the house in 12 equal
instalments at the end of each year. If money is worth 8% p.a. effective, what would be the
size of each instalment? In case Ms. Pallavi makes a down payment of ~ 2,50,000, what would
be the size of each instalment?
12. A company wants to buy a machine for ~9,00,000 that will yield an income stream of f21,300 per
month for the next 6 years. If a loan can be obtained to buy this machine at 9% p.a. compounded
monthly, find whether the investment is worthwhile or not.
13. A person is contemplating to install a photocopying machine at a cost of f 12,00,000 with a
productive life span of 8 years during which the machine is to be maintained by the supplier
free of cost. He knows that on an average, he can photocopy 6000 pages per day and charge
30 paise for each page from the customers. The toner cartridge needs replacement after 4000
pages at a cost of ~ 800. If a loan can be obtained to buy this machine at 12% p.a. effective, '
find out whether the purchase of this machine is worthwhile or not, assuming that the machine
will be put to use for 360 days in a year.
14. A company wishes to invest ~21,000 in a machin~ that will ~eld an income strea~ of ~3,900
per year for the next 9 years. If money is worth 91/o p.a. effective, find whether the mvestment
is worthwhile.
lS, Machine A costs f 1 50 000 and has a useful life of 15 years. Machine B costs ~ 1,25,000 and
has a useful life of i2 ;ears. Suppose Machine A generates ~n annua~ savings off 20,000 while
tnachine B generates an annual savings oft 25,000. Assummg the time value of money is 5%
effective, which machine.is preferable?
l6, A person b 000 at 10% compounded annually, repayable · in 10 equated annual
. orrows 4 , 50, h . f 7 h . al h .
instalments at the end of each year. However, at_ t e ti~e o t mst ment t e mdividual
elects to pay off the loan. How much should be paid by him to settle the account?
12.42 BUSINESS MATHEMATICS

1 7: If the present value and amount of an ordinary annuity off 1 per annum for a certain number of
years are f 10.20 and f 21.95 respectively, find the rate of interest and the approximate.number
of years. · I f

18. An automobile advertisement reads: "No money down. f 8,000 per month for 36 months, interest
rate equals 9% per year compounded monthly on unpaid balance." How much of f2,88,000 to
be paid will go for interest and how much for the vehicle itself? t· • r·, . - r. _., 1 • ,
I .. ,,
r • I •
I
l- •
,L
Annuity Due
19. Mr. Anuj wants ?7,50,000 at the end of 9 years. If the rate of interest is 10% p.a., what amount
should be deposited at the beginning of each quarter so as to get the above amount? · ' ·
20. You haye just won a million rupees; the prize is ·a warded in 12 years by quarterly payments of
f 35,000 each. The quarterly payments are received ·at the beginning of each quarter. ,You are
given the option of receiving ·a single lump-sum payment of ~9,00,000 instead of the f35,000
rupees in each quarter. You want to find out which option is more in today's-rupees. Money is
worth 12% compounded annually. .,, . , ,. , .. . ,
21. Mr. X purchases a house for ?3,00,000. He agrees to pay for the house in 7 equal instalments
in the beginning of each year. If money is worth 8% p.a. effective, what would be the size of
each instalment? · -, • ·.. ~ ._ ' • · ~
22. Mr. Jagdish purchased an asset for f 5,60,000 on instalment basis. Each Jnstalment is to be paid
at the beginning of each quarter. 'Find the size of each instalment if the money is to be repaid
in five years and the rate of i~terest is 12% compounded quarterly. · I
I
Perpetual Annuity
s Find the amount to be deposited into an endowment fund that is to be compounde d a~ually. at
·. the rate of 12% p.a. to provide for an annual sch?larship of ~ 36,000 for an indefinite
3

period of time.
39. The principal amount demanded by a bank to guarantee a perpetual annuity is reduced by 25%
after rate of interest compounded annually in increased ·by 3%. Find out the rate of interest
allowed by the bank after reduction in .principal amount.
40. How much money is n eeded to ensure a monthly pension of ~ 80,000 at the beginning of each
month forever, if the money is worth 10.5% p:a. compounded monthly.
41. How much money is needed to ensure a series of lectures costing ~ 4,500 at the beginning of
each year indefinitely, if the money is worth 6% compounded annually.
42. How much money is needed to ensure a pension of ~ 42,000 at the end of each year forever that
grows at the rate of 3% p.a., if the money is worth 10% p.a. compounde d yearly.
- _ _I! 'T""\.----- • -L • ---